The trend of high inflation and increasing interest rates will undoubtedly persist well into the first half of 2023. Many economists are also predicting that many economies will grow at low or even negative rates, with some even slipping into a recession this year.
Although this seems like a morbid tone to start the year off, understanding the reality of the current global financial situation will allow a proactive approach to your finances rather than a “hope-for-the-best” strategy.
In this article I would like to highlight the most important proactive step to take in this year particularly and that is managing and prioritising debt.
According to the Bureau for Economic Research (BER), the South African Reserve Bank (SARB) is expected to bump up interest by another 25bps at their first meeting of 2023, scheduled for the 26 of January, taking the prime rate to 7.25%. Although the SARB is not likely to increase the repo rate as aggressively in 2023 as they did last year, they will certainly not ease it anytime soon either.
Due to lockdowns following the Covid pandemic, SARB reacted, along with the rest of the world, by bringing down interest rates significantly in an effort to aid the struggling economy. Interest rates were therefore unsustainably low during this period with the consequence that the recent hikes can also be seen as a return to a “more normal” level for interest rates.
With this period of cheap money behind us, prioritising debt repayments must be pushed up the list of expenses to prioritise. Sit down and make a list of your loans along with their respective interest rates.
Although each monthly instalment should be part of the expenses in your budget, this exercise will help you prioritise which debts have higher interest rates and should therefore be paid first when you have a bit of extra cash available.
Generally, asset-backed debt such as vehicle finance and home loans are the cheapest forms of debt, due to these being secured by a physical asset that makes them less risky for the banks. This is because if a consumer defaults the bank can repossess or sell the asset and retrieve their loan amount back.
Personal loans, clothing accounts and credit cards are more expensive than vehicle or home loans as there is no security for these debts. Therefore, it can be harder for the bank to get its money back from defaulting consumers.
In a recent consumer survey by TransUnion, only 60% of participants admitted that they monitor their credit debt monthly, although 96% admitted that they know they should keep track of their debt. This confirms that although most of us know what responsible behaviour is, we unfortunately often neglect making it a priority.
With rates increasing, a bigger portion of your monthly expenses will be debt repayment, so make sure to not let debt, and especially high interest rate debt, or as it is also often known, short term debt, spin out of control.
Paying off these high interest rate debts really should be considered your first step to building a solid financial roadmap for you and your loved ones over the long term. Only after high interest debt is repaid, it is advised to start saving towards long-term financial goals.
This statement has some keywords that should not be misunderstood. Firstly, it is not saying to not save any money at all, but rather that saving towards long term financial goals should be pushed out. This means that keeping your emergency fund topped up, for example, should always be a priority since it is key to your financial well-being. Short term financial obligations should also not be neglected, and it is key to identify them and save for them when needs be.
Secondly, we are referring to high interest rate debt such as credit card debt and clothing accounts for example rather than bonds or vehicle financing. The reason for this is that most investments do not guarantee a return and usually have some form of risk associated with it.
Any investment that can grow at a rate higher than the interest rate on these kinds of loans will without a doubt come at a rather high risk. Therefore, it only makes sense to pay off high interest loans that will guarantee you save on the high monthly repayments, before using that money to invest in high-risk investments.
Make 2023 the year in which your high interest rate debt is brought under control, motivated by the heightened interest rates, setting you up for a prosperous financial road ahead.
